momagri, movement for a world agricultural organization, is a think tank chaired by Christian Pèes.It brings together, managers from the agricultural world and important people from external perspectives, such as health, development, strategy and defense. Its objective is to promote regulationof agricultural markets by creating new evaluation tools, such as economic models and indicators,and by drawing up proposals for an agricultural and international food policy.

Flexible incentives, a truly good idea for the CAP budget

October 22, 2012

The scheduled reform of the Common Agricultural Policy (CAP) generated a debate on the merits, or absence, of flexible or counter-cyclical incentives to farmers. Many experts are therefore taking a position on this issue, using the same arguments that prevailed in the early 2000s. Yet, the world has evolved and the current situation of agricultural markets is radically different. 1) Price volatility is increasing and this is a fact; 2) Budget tensions are much higher and the search for a better effectiveness of financial aid is now a requirement; 3) Regulating agricultural markets is necessary since they do not self-regulate.

We must not forget that in matters of economic policy, the questions remain unchanged and only the answers vary, because of depressed markets, structural turmoil or new power relationships. So yesterday’s answers may not be those that are suited for today, and the skill lies in making the best decisions, which are generally the less irreversible in an increasingly uncertain world.

Consequently and measuring up this new environment, it seems that flexible incentives are a truly good idea, and this for four reasons.

They are economically efficient. The issue of counter-cyclical payments arises in a lesser amount in in relation to higher or lower price levels––and we know they can change rapidly––but more in relation to price hyper-volatility. In such context, flexible incentive are economically more effective than decoupled flat-rate aid to allow farmers to face a temporary difficult situation. In fact, these incentives have little legitimacy when prices are high––which is the case today––and are very often insufficient when prices are too low. Various studies1 have been conducted in Europe to assess the impact of initiating flexible incentives to replace decoupled aid on the volatility and incomes of two types of producers: grain and dairy. It then becomes apparent that, in fact, incomes would be less volatile on the long term, and reach comparable levels to those recorded without generating the overproduction that some observers strongly fear.

They are fiscally efficient. Taking into account the hyper-volatility prevailing in agricultural markets, flexible incentives provide budget savings over the long term, as compared the current situation, provided they are defined by floor and ceiling thresholds, as was done in the United States or Brazil. Simulations2 were made in the framework of the CAP to assess the budget consequences of the end of decoupled incentives for the grain and dairy sectors (that is to say 60 percent of the CAP’s first pillar). As far as the 2006-2011 period is concerned, the budget costs would have been lower than actual expenditures, an average of €10 billion per year. The same holds true in a recent American study3, which shows that the termination of all existing agricultural incentives in the Farm Bill, and their replacement with aid for private counter-cyclical reserves, would stabilize farmers’ incomes at comparable levels, while obtaining substantial budget savings ($7.4 billion annually) for the 1998-2010 period.

They are strategically necessary. The CAP reform is taking place in a context of unprecedented price hyper-volatility, in which fixed and flat rate payments have very little impact. More generally, the specific risks, to which agricultural markets are exposed, are preventing farmers to manage them alone and in the long term. In fact, as they lack visibility, farmers cannot commit to durable investment schedules, since the risks of market turnarounds are too high in the absence of effective safety nets. Such situation represents a genuine threat for the stability and competitiveness of European agriculture, all the more so since other major agricultural powerhouses (United States, Brazil and China in particular) are implementing measures to secure their agricultural output through counter-cyclical support mechanisms and greater budget flexibility to adjust to market volatility. Europe must commit to this process and reverse the current rationale, so that the CAP can stabilize farmers’ incomes through a flexible budget, and not stabilize the agricultural budget at the cost of higher income volatility.

They are politically tolerable. The current crisis has deeply altered the views of European decision-makers regarding the challenges of the CAP, whose priority objective is, among others, to better manage price instability at a lesser cost. Yet, flat rate decoupled incentives were never aimed to protect farmers from international price fluctuations. And since some members are now questioning the CAP budget, decoupled incentives might be deeply curtailed, due to their predominant part (60 percent). As a consequence, the implementation of an alternate and flexible system that would guarantee farmers with identical compensations while stabilizing them at a lower global cost over the long term, is now an option of interest for European as well as international decision-makers. In addition, such a system has the advantage of being WTO-compatible for Europe, and remaining in the authorized margins of the orange and blue boxes. Lastly, it can be implemented in Europe, provided that slight budget procedures are adapted, and that a multi-annual reserve fund is established.